J. Bradford DeLong
How appreciated or depreciated the exchange rate is relative to its long-run fundamental purchasing- power-parity level depends on (a) the magnitude of the expected differential in interest rates between the home and foreign countries, and (b) the expected duration of the interest rate differential.
The shorter the expected duration, the less will be the deviation of the current exchange rate from its ppp value; the longer the expected duration of the differential, the greater will be the deviation.
The larger the differential in interest rates at any one point in time, the larger the difference between the initial exchange rate and its ppp value; the smaller the differential, the smaller the appreciation or depreciation of the exchange rate.
|Short-Run Value of the Exchange Rate Interest and Exchange Rates|
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